Strategies for Currency
UnificationThe Economics of Currency Competitionand the Case for a European
Parallel CurrencyDr.
Roland Vaubelwrote the 13 page summary of
his 400 plus page academic beautwhich was scanned, correctedand is now within a few pagedown
keytaps reach below, but first:Those of you unable to obtain
this ponderous tome but interested enough in the subject matter may just
contact the IEA in Londonand order the 32 page pamphlet
(transcript of a '79 lecture)of which you see the cover page
and table of content next:Choice in European Monetary
UnionNinth Wincott Memorial Lecturedelivered at the Institute of
Bankers, London,on Wednesday, 6 December, 1978ROLAND VAUBELUniversity of KielThe Trustees of the IEA have agreed that any
surplus over costs arising from the safe of this paper should be donated
to the Wincott Foundation.INTRODUCTIONGLOSSARY OF TECHNICAL TERMSTHE AUTHORPublished byTHE INSTITUTE OF ECONOMIC AFFAIRS for THE
WINCOTT EOUNDATION1979ContentsIntro by Lord RobbinsI THE NEW EUROPEAN MONETARY SYSTEMII AN EVALUATION OP THE SYSTEM(i) Pooling of monetary reserves(ii) Extension of international credit
facilities(iii) Foreign exchange interventions(iv) Return to an adjustable-peg exchange
system(v) Difficulties of operating a 'snake'-type
system in the EEC

(some comments by yours faithful added in fiery redand all emboldenments are your digitalizer's
also)402
SummaryThis is written for the busy reader. It is notably
written for the practical political economist, for it concentrates on the
policy implications rather than on the theoretical innovations of this
study. More specifically still, it is written for those practical economists
who are prepared to look beyond their day-to-day business and to think
in terms of years and decades rather than weeks or months. Finally to add
a further limitation, it is written for those interested practical economists
whose approach to policy consulting is not merely to forecast the probability
of each possible policy action being taken and then to come out in favour
of the most probable one, but to recommand what they have realized to be
desirable and necessary and to try in a personal effort to change the probabilities
of the possible policy actions in favour of the optimal solution.

A policy action cannot
be a solution, let alone the optimal one, unless it is possible. however,
what is possible is difficult to judge. To many present observers, the
aim of monetary union in Europe may seem as unattainable as the creation
of the Common Market must have appeared to those who thought about it in
the 1930s and '40s. However economic circumstances and political constellations
change, and with them the (defunct?) economists who somehow manage to influence
gover nulent policy. With
respect to European monetary unification, we observe not only polltical
charges but also an important economie development the market reduction
in the effectiveness of monetary expansion, of inflation and of the associated
external currency depreciation in alleviating unemployment. High constant
rates of inflation no longer have a recognizable effect on employment,
and high variable rates of inflation, by increasing uncertainty and inefficiency,
seem to reduce employment: the temporary increase of employment in the
phase of accelerating inflation is smaller than the temporary decrease
of employment in the phase of decelerating inflation. The reason for this
change ln the economy's response to monetary-policy impulses is the adaptatlon
of expectations to policy instability, the so-called erosion of money-(including
exchange-rate) illusion. The implication of this catching-up process is
a need for preannounced(how about project specific?
Sound good to you too?) rather than impulsive monetary expansion,
for price-level stability rather than inflation-rate variability and for
a reduction or elimination, rather than an increase of exchange-rate charges.
Thus, the chances for monetary union are likely to become better rather
than worse...............The theoretically-minded reader
is referred to the survey which is given in the introductory outline and
to the partial summaries on pp. 98-99, 153-154, 289-290, 322-323 and 346.403 Starting
from this basis, this study has analyzed and compared various strategies
for monetary unification:on the one hand, the coordination approach with its
variants:(i) exchange-rate unification,(ii) monetary-policy harmonization and(iii) a combination of the two,on the other hand, currency unification with its variants:(i) "big-leap strategy",(ii) free currency competition and(iii) parallel-currency approach.
Exchange-rate unification is defined here as the fixing of exchange rates
without ex ante harmonization of monetary policies, let alone cantralization
of monetary policy in the hands of a European central bank. Exchange-rate
unification is rejected because it involves foreign-exchange interventions
and requires a hegemonial currency. Foreign-exchange interventions are
considered undesirable on general welfare-economic grounds becall se they
involve avoidable internationa externalities, i.e. interference with the
monetary policy of foreigr countries. Moreover, the present system of intervention
under which weak-currency countries obtain external seigniorage through
subsidized credits or a reserve-currency role, is criticized for its moral
hazard: its incentive to inflate and, ultimately, its self-defeating nature.
If foreign-exchange interventions are ruled out, exchange-rate fixing can
only be maintained if domestic monetary policies are continually adjusted
to attain external equilibrium. But who is to adjust to whom?. If at all
it will be the smallest countries which adjust to the larges countries
(country) because for the smaller countries, being more open, the benefit
of exchange-rate constancy has a-larger weight as compared with domestic
objectives (price-level stability) than for the larger countries. However,
the satellites will only adjust as long as the hegemonial-currency country
offers an acceptable performance Since the benefits of exchange-rate constancy
are not fully internalized by the hegemonial-currency country, it does
not have a sufficient incentive to conduct a monetary policy acceptable
to the satellites. Thus central bank charters with an informal price leader
tend to be unstable and short-lived. Moreover, it has been shown that,
also on economic grounds, the deutsche mark is a particularly inappropriate
pivot currency for the European Community. Monetary-policy harmonization without
fixed exchange rates can only lead to monetary union if rates of domestic
monetary expansion can be found and agreed upon ex ante which make free
exchange rates con 404
stant exchange rates. Quite apart from the very high political friction
and the past failure ofthis strategy (1973), it has been shown that the
income elasticities of the demand for moneyend the real exchange rate charges
within the Europe an Community do not seem to be sufficiently stable to
permit the attainment of exchange-rate constancy through mere ex ante harmonization
of domestic rates of monetary expansion. Exchange-rate agreements
and monetary-policy agreements may be combined in a simultaneous ex ante
commitment. The easiest way would be to agree on the rate of money-supply
growth for one member country and to oblige all other member countries
to maintain fixed exchange rates vis-à-vis the currency of that
country by adjusting their domestic monetary policies. The obvious (political)
disadvantage of this strategy is that it still appears to involve a currency
hegemony. The other variant of the simultaneous commitments approach is
to agree in advance on each member country' s rate of domestic monetary
expansion, to choose these rates in such a way that they are expected to
beconsistent with exchange-rate constancy and to correct for any errors
that may subsequently becorne apparent by rnaintaining the agreed exchange
rates through symmetrical foreign-exchange interventions. This solution
has the advantage of not involvingexternalities or morel hazard and inflationary
bies (because monetary end exchange-ratepolicy
would be entirely predetermined by consent).
But although it would be a considerable improvement on present arrangements
(the "snake"),
it still suffers from many drawbacks of both approaches which it combines.
Since it maximizes political friction, the required agreements are unlikely
to be concluded, and if they are concluded, they probably will not be kept
(or only at the cost of restrictions of capital
movements end even of trade).To suggest that
exhange rates between the member currencies could remain permanenty fixed
as a result of regular negotiations and complete coordination mong nine
governments or central banks is to presuppose a "brave new world of which
we have no experience and which seems inconsisent with our observations
of politica! end bureaucratie behaviour. It is the common and
crucial defect of all variants of the coordination trategy that they rely
on discretion instead of automaticity. This lack of automaticity manifeste
itself in four ways: There is no way of ensuring automatie ex ante consistency
of price targets (exchangerates) and quantity targets (money stocks). Since the participants
retain their power of discretion and the instrurnents to exercise it,there
is no automatic mechanism which prevents them from violating the coordination
agreement. 405~ 1 A fortiori, there is
no way of ensuring that the coordination agreement(s) will automatically
be renewed. A fortiori, there
is no automatic process by which discretion (the
possibility of opting out) is reduced over
time. Since the coordination
approach lacks automaticity, it fails to make exchange ratespredictable.
If it involves the fixing of parities, it may indeed lead to more errors
and uncertainty than exchange-rate flexibility and the pre announcement
of definite rates of national money supply growth which exchange-rate flexibility
makes possible. The failure
to give guidance to expectations tends to perpetuate itself in a vicious
circle. Any strategy which makes it easy for member governments to opt
out tends to be self-defeating because it leads trede unions end entrepreneurs
to assume that the national authorities will yield to their pressure. Wage
and price setting then becomes inconsistent with the government's international
commitments, national monetary policy accommodates to (try to) avoid a
rise in unemployment, and the exchange-rate target has to be abandoned.This,
in turn, strengthens the public' s expectations of government compliance
even further,etc. Since, in terms of risk and transaction costs, the maintenance
of national currencies has many obvious economic disadvantages as compared
with currency unification, the public's expectations can even be regarded
as entirely rational; for it is difficult to see why exchange-rate unification
could ever be preferred to the adoption of a unique common currency ("currency
unification") by the member governments, if the latter were unconditionally
committed to exchange-rate fixity. They do not dare to undertake unconditional
commitrnents because they have experienced a "need" for accommodation in
the past, not realizing that this "need" was the result of their failure
to cornmit themselves unconditionally in the first place. The circle cannot
be broken unless the authorities renounce their discretion. Currency unification,
being as irreversible and credible as any unification can be, tends to
be self-fulfilling: economie agents know what to expect and what to adjust
to, and they will find it in their interest to avoid a collision. The problem
of expectation adjustment is also the key to another defect of the coordination
approach. The coordination approach requires an assimilation of inflation
rates. Since the member countries with the lower rates of inflation are
unlikely to accept an acceleration of inflation for the sake of exchange-rate
unification, the more inflationprone members will have to (continue to)
follow strongly disinflationary policies. The downward harrmonization of
monetary rates of expansion and inflation is liable to produce temporary
reductions in the 406 level of employment
because inflation expectations are slow to adapt. No such cost of transition
arises if the inflating national currencies - instead of being stabilized
- are replaced by a new currency which especially if it is subject to value
guarantees and issued by a new and independent institution, does not suffer
from a record and expectations of inflation. This is why many times in
history governments have preferred currency reform to currency stabilization.
If the new currency is the same for all member countries, currency reform
coincides with currency unification: instead of nine currency reforms there
would be only one. The most obvious approach to currency
unification is the "big-leap strategy, " i. e., the uno actu displacement
of the national member currencies by a unique Community currency. From
a political point of view, this strategy has the disadvantage that the
currency unification process would start later, if at all, and involve
more political friction, than a gradual approach. From an economie point
of view a gradual transition to currency union would facilitate the adjustment
of expectations, contracts and accounting and, hence, minimize mis-allocation
of resources and government interference with contract denominations. However,
since there are also costs to prolonged currency coexistence, (and
methinks that's not the only nor best reason why)it
is important that the speed and pattern of currency substitution should
be left to the market. Free currency competition among
the national member currencies is likely to lead to currency union and
to permit both automaticity and gradualism in the process, if the use and
production of money is subject to gradually but permanently increasing
returns to scale (money production as a natural monopoly). Moreover, during
the transition to currency union, free currency competition would serve
to fight inflation and tering about dynamic optimum currency domains in
the European Community. These three main effects of free currency competition
have been analyzed in great detail, including the possibility of a free
and competitive private supply of (base) money and the theoretical objections
that have been advanced against it.It has notably
been argued that, in the presence of a government-issued legal (but not
forced) tender, competition between private suppliers of base money will
result in value-maintenance provisions guaranteeing a constant or even
increasing purchasing power for the private "parallel" currencies.The
objection that the use of money produces Pareto-relevant real-income externalities
or that money is even of a public-good character has been refuted. Gresham's
Law has been shown to be inapplicable in the absence of a fixed forced
(or legal) disequilibrium exchange rate between the concurrent monies.If
free currency competition and, hence, exchange-rate flexibility is permitted,
"good rmoney chases bad money" (the Anti-Gresham Law) instead of the reverse.407 The
only valid objections to currency competition between the nine member currencies
seem to be that it would involve the stabilization of at least the surviving
national member currency (and, therefore unnecessary
stabilization unemployment) and that the less
competitive issuing countries, threatened by a loss of seigniorage and
prestige to the prospective winner, would not admit the competition. By
contrast national member central banks might have an economic incentive
to accept competition from, and displacement by, a Community currency if
they shared in the seigniorage accruing from its issuance and if it could
be expected to make inroads into the currency domains of non-member currencies
(notably the dollar). Political as well as economic considerations thus
indicate that competition and substitution should take place not between
the national currencies, but between each national currency and a new Community
currency.
This is the case for the parallel-currellcy approach to European currency
unification. It implies that the European parallel currency (EPC) should
be so stable that it need not be stabilized. This rules out all proposals
which view the EPC as a pivot or average (basket) of the inflating member
currencies or which provide for a link between the EPC and the ab initio
"strongest" member currency. Moreover, it is very doubtful whether a less
than stable EPC would be sufficiently attractive to be able to overcome
the barriers to entry, which an infant currency has to face, and to outcompete
the established national member currencies. The examination of a large
number of potential valuation formules and the detailed discussion of the
nature of domestic inflation risk, real exchange-rate risk and nominal
exchange-rate risk and of ways to obtain protection against them (through
indexation, currency diversification and hedging/forward cover, respectively)
have yielded the result that the EPC would most appropriately be defined
as a basket of weighted amounts of the national member currencies that
would each be increased whenever, and by the same percentage by which,
the respective member currency lost purchasing power as measured by the
national consumer price index. While the indexed basket formule minimizes
inflation and real exchange-rate risk, it does not minimize nominal exchange-rate
risk (a bilateral or multi currency fixed-amount
basket would) or exchange-rate information
cost(par-valuation would)
or the deviation from the money-holding optimum (a
basket whose purchasing power increased at the real rate of interest would).
However, since exchange-rate information cost is relatively srnall, since
norminal exchange-rate risk is relevant om:in the short run in
which old national-currency contracts have not yet matured, and since seigniorage
can be eliminated through interes payments on all types of money except
currency in circulation, an EPC 408 defined
as an indexed basket of the member currencies seems to offer a maximum
of advantages.
Since the EPC is to be subject to a value guarantee that would be validated
instantaneously and exactly through exchange-rate adjustments vis-à-vis
the basket of national member currencies, the EPC Bank would have no discretion
as to the quantity of EPC, Supply would have to adjust to demand so that
the automatically changing guaranteed exchange rate vis - à -vis
the member currencies would be the equilibrium exchange rate. This means
that, for the purpose of "controlling" the EPC supply, there is no need
to impose reserve requirements for EPC deposits with central banks: if,
for example, the voluntary reserve ratio fell and the effective deposit
multiplier increased, the EPC Bank would ceteris paribus be forced to validate
its value guarantee by withdrawing EPC base money so as to keep the EPC
money supply constant. It also means that no ceiling could be put on EPC
expansion if the EPC were to be both standerd and store of value.
Interference with the monetary policies of the me mber states is minimized
if the EPC is not issued to finance Community expenditure and loans or
to purchase financial assets but issued in exchange for the member currencies
at the guaranteed rate. In this way, any shift of demand from the national
member currencies to the EPC could be matched by an equivalent substitution
of EPC supply for member-currency supply without effects on total money
supply in the European Community and on the national inflation rates and
exchange rates. lf the national currencies were not withdrawn pari passu
with the issue of EPC, inflation would reduce the value of the increased
nominal money balances until the equilibrium value of real money balances
were restored. Since an EPC of constant purchasing power cannot, by definition,
be subject to inflation, the adjustment would ceteris paribus have to be
brought about through inflation and depreciation of the national member
currencies. This means also that the national central banks should not,
in principle, reissue the amounts of national currency which the public
sells to the EPC Bank and which the EPC Bank withdraws from circulation.
The target which each national central bank may - hopefully - have and
announce with regard to its national monetary base should not be confined
to national currency in circulation and national-currency reserves of domestic
banks but it should also include the central bank' s liabilities to the
EPC Bank. By doing so, each national central bank would also allow tor
the fact that its target rate of increase of high-powered national money
would partly be supplied already as a result of the nominal increase of
its national currency liabilities to the EPC Bank which the EPC purchasing-power
guarantee and the payment of interest on the EPC reserves of com 409
mercial banks imply. For if the balance sheet
of the EPC Bank is to remain in balance, its claims un the national cantral
banks (the balances of national member currencies) must be indexed and
beer interest just as the outstanding volume of EPC. The national
central banks would thus lose seigniorage on the monetary base underlying
that part of the national money supply which has been rejected by the public
in favour of EPC. Their loss would be the same if the EPC Bank invested
its national currency proceeds in the private capital and Euro-currency
markets, for if the national cantral banks still wanted to attain their
price-level targets, they would have to withdraw an equivalent amount of
their national monetary base from circulation. This would notably hold
if the EPC were also issued in exchange for non-member currencies (say,
the dollar) and if the Federal Reserve System did not agree to cede the
corresponding part of its seigniorage to the EPC flank (and, ultimately,
to EPC holders).
The principle that each addition to the EPC supply should be matched by
an equivalent reduction of the national currency supply on a one to-one
basis has to be modified only to the extent that the introduction of a
stable and interest-bearing European currency raises the demand for real
balances or to the extent that the effective multiplier (reserve ratio)
for high-powered EPC differs from the effective multiplier (reserve ratio)
for the high-powered national currency supply which it replaces. If the
EPC were only issued in exchange for national membe r currencies, the demand
for the mermber currencies may also increase because original owners of
non-Community currencies wish to temporarily hold member currencies for
conversion into EPC. Most conveniently, the national high-powered money-supply
targets might be adjusted ex ante to allow for these effects. It has been
argued that in order to minimize short-term intra-Community cross-rate
effects and conversion costs, the EPC should be issued to EC residents
in exchange for the current basket equivalent of their national currency,
while with regard to non-EC residents strict basket conversion is preferable
both from a cross-rate and an external seigniorage point of view.
Proposals to confer the functions of money only gradually upon the EPC
have been rejected becall se only a fully-fledged new currency is likely
to be able to overcome the barriers to the entry of an infant currency.
Proposals to restrict the use of the EPC for specific purposes have been
rejected for the same reason and becall se such restrictions are inconsistent
with the exploitation of the comparative advantages of the different monies.410 The
analysis of the prospective speed of EPC penetration has shown that the
process is likely to be gradual and that, for various reasons, gradual
acceleration will be followed by gradual deceleration. With regard to the
pattern of EPC expansion, it has been shown that as a standard of value
it will initially be in greatest demand for large longterm contracts between
non-financial institutions in countries where inflation risk and real exchange-rate
risk are high and money illusion small.
As a store of value the EPC is most attractive for internationally oriented
companies and large holders of notes and coins in high-inflation cantral
member countries. As a means of payment the EPC is least unlikely to be
used in open central member countries between residents who happen to hold
store-of-value EPC. The partial criteria which are identified offset each
other to some extent. Whether the market's choice of currency will lead
to EPC expansion mainly in the central or the peripheral countries depends
on whether, in the present inflation-ridden European Community, the theory
of optimum currency areas or the theory of optimum stabilization domains
has moreweight.
In theory, the national central banks could be left free to issue national
money ad infinitum. However, after some time, such sovereignty could become
purely formal; for if all newly-issued national money were immediately
exchanged for EPC at the EPC Bank, the national central banks would no
longer earn seigniorage or conduct a monetary policy. It is advisable to
stop new issues of national money and, perhaps to transfer the status of
legal tender from the national currencies to the EPC, once (and as long
as) the EPC accounts for an overwhelming proportion (say 60 percent) of
total real balances from Community sources. The precise percantage should
be agreed and announced in advance. The EPC Bank would then become a genuine
cantral bank and take over control over the total money supply in the European
Community, hopefully by announcing a. rate of EPC money supply growth that
is consistent with continued purchasing power stability. This "limping
union-currency standard" would be succeeded by full currency union when
the last holder of national member currency chose to convert it for what
would now become the unique Community currency. Perfect currency competition
would no longer be simulated by a duopolist but by a monopolist.

To summarize, the parallel-currency
approach possesses at least nine characteristics of an optimal currency
unification process: 1. It
works without foreign-exchange interventions and, hence, with out international
externalities and morel hazard or ex ante agree411
ments
on national rates of money-supply growth. 2. It triggers
an àutomatic mechanism which works without politica! discretion
and which leads to currency union in a predictable and self-fulfilling
process. 3. payment
at a very early stage, thus facilitating market integration while still
leaving control over national monetary policies with the member governments. 4. It
has all the political and economie advantages of gradualism. 5. It
permits the speed and pattern of currency unification to be determined
by the nceds of the market and the degree of money disillusionment. 6. It avoids
the temporary unemployment that would be created by the downward harmonization
of inflation rates of the national member currencies. 7. It does not
encoura~e competitive inflation, but through competition tands to discourage
it. 8. It avoids
nationalist rivalries and hegemony. 9 It gives the
monetary all thorities in the European Community a positive incantive to
desire or accept EC currency unification. By contrast,
the traditional coordination strategy does not qualify on any of these
counts except one (4. ).The standard objections against
the parallel-currency approach are that it leads to(i) inflation,(ii) exchange-rate instability
and(iii) monetary inefficiency, or(iv) nowhere.It has been shown in this study
that inflation will not result if the issue of EPC is offset by withdrawals
of national member currency in an automatie conversion mechanism. Exchange-rate
stability should be attained not by restricting the choice of currency,
but by requiring the adjustment of supply to demand as in other lines of
production. Consumer sovereignty in the field of money will not be inefficient,
for the production and use of money does not give rise to Pareto-relevant
real-income externalities. After all, everybody will be free to reject
the EPC if he prefers the national currencies. The parallel-currency approach
would lead nowhere if it were an attempt to coax European politicians into
an action which they did not really wish to undertake. The trick would
be discovered and, ultimately, rejected by them. However,
the parallel-currency approach is not a ruse designed to dodge the political
process.412
It minimizes political friction, but it is not conceived as a substitute
for political agreement on the desirability of currency union. There can
be no such substitute. The reason why it has not yet been tried by the
European Community (or a group of its members) is not that it is not the
optimum currency unification process, but precisely that it would lead
to currency union and that several, if not most, member governments do
not seem to desire currency union.The
parallel-currency approach to European monetary unification cannot become
operative before the destruction of money illusion in the markets has been
followed by a destruction of Phillips-Curve illusion on the part of (a
sufficient number of) member governments.
Unlike the first part of this study the second is empirical in nature.
Its first three chapters contain a quantitative analysis of several issues
which have been addressed in the first part. At the and of each chapter
the main findings are summarized so that there is no need to repeat them
here (see pp. 229-230, 322-323 and 346). For this reason, the following
paragraphs will merely focus on those results which are of direct relevance
to the arguments presented in this summary.
As has been explained, the traditional coordination approach to European
monetary unification is inferior to the parallel-currency approach. The
European Community's failure to make progress towards monetary union may,
therefore, be due to the choice of a suboptimal strategy. A competing explanation
is that the European Community is an undesirable currency area or that
it has become one after 1971. The analysis
of internal real exchange-rate charges in Chapter I has shown that the
European Community is probably indeed a less desirable currency area than,
for example, West Germany, Italy and the United States but that only a
small part of the failure can be attributed to structural economic causes:
two thirds of the nominal exchange rate charges are due to the member governments'
unwillingness and/or inability to coordinate. The official
excuse that the 1971 strategy for EC monetary union, while being justified
and realistic at the time it was adopted, was largely thwarted by unforseeable
external disturbances (such as the dollar
"crises," the increase in the price of oil and other raw materials, and
the recant world depression) seems to
be disconfirmed by the evidence. If an attempt is made to allow for the
increase in roal exchange-rate variability which the transition to floating
is lilmly to have brought about in the short and medium term, the need
for real exchange-rate413
charges
within the European Community seems to have decreased instead of increased
since 1971. What has increased is not the structural differences and divergencies
among the member countries but the unwillingness and/or inability of their
governrments to coordinate monetary policies. These
results imply that the economic case for European currency unions is at
least as strong now as it was in 1971. Moreover, the real exchange-rate
criterion has been shown to permit the identification of a pioneer group
of rmertiber countries that would be most suited from an economie point
of view for a first start with currency unification (through the parallel-currency
approach). The group consists of the present five EC members of the
"snake" plus France. The analysis
of the foreign-currency preferences of depositors, official reserve holders
and bond issuers which has been presented in Chapter II derives only a
small part of its importance from the implications which it has for the
parallel-currency approach. Nevertheless, these implications are worth
ermphasizing. First
of all , there is abundant evidence that non-bank depositors and bond issuers
(and even central banks) are averse to exchange risk. While depositors
and central banks reduce their holdings of foreign currencies when unexpected
exchange-rate charges have occurred, bond issuers reduce their issue of
bonds denominated in a currency that is foreign to them not in response
to exchange-rate variations but in response to the abandonment of parities.
Moreover, they react by somewhat increasing the proportion of unit-of-account
bonds in their issue. Thus exchange-rate flexibility has raised the demand
for a composite unit like the EPC. Secondly, the
analysis has shown that non-bank depositors (unlike cantral banks) evaluate
exchange risk not in terms of (past) nominal exchange-rate charges but
in terms of real exchange-rate charges (and of deviations of the spot rate
from the past forward rate). This means that an indexed-basket EPC which
protects primarily against real exchange-rate risk will be a more attractive
and useful money than a fixed-basket EPC defined on the lines of the new
European Unit of Account. Thirdly,
depositors (including cantral banks) and bond issuers prefer currencies
which, in the long run, are subject to least inflation (or which, for other
reasons, are expected to appreciate). In the money market, this preference
for "strong" currencies is largely indepandent of observable covered arbitrage
margins. A currency of guaranteed purchasing power like the EPC is thus
likely to be in great demand as a standard and store of value 414
Fourthly, the evidence indicates that yield and risk conaiderationa are
of less importance ior the choice of a deposit currency than the size of
the transaction domain. A new currency like the EPC which initially lacks
transaction economies of scale is therefore likely to spread relatively
slowly and gradually as a deposit money. Index clall ses relating
to the national consumer price index may be viewed as a parallel standerd
of value just like foreign currencies or multi-currency units of account.
Thus the last of the three quantitative chapters contains an analysis of
the determinants of the extent of ("demand for") indexation in four countries
and with regard to four types of contract. The evidence indicates that
the demand for an indexed standard of value like the EPC will be stronger,
the larger the rate, and the increase (but not the decrease) of the rate,
of inflation. It reacts with a lag of up to one year. Just as there remains
a large number of new non-indexed contracts even in galloping inflation,
many indexed contracts are concluded even in conditions of price-level
stability. The inflation-autonomous part of indexation demand is larger,
the longer the term of the contract. Thus even at low rates of inflation,
the EPC will be demanded as a long-term standerd of value.The last chapter of this study
has presented the history of the parallel-currency approach and of currency
competition.With regard to private currency
competition, the analysis shows that the competitive supply of private
(base) money has worked welf where, like in Scotland and Switzerland, the
state did not interfere with the policies of the issuing banks but merely
rigorously enforced the law against fraud, and that inflation and bankruptcies
were the result where, like in France (during the 18th cantury) and the
United States (during the period of "wild-cat banking"), the state(s) meddled
with the banking business and/or confounded freedom with lawlessness.More important, a look at history
reveals several cases in which parallel or dual currencies have been issued
by governments with considerable success, either to get rid of inflation
without a stabilization crisis or to tering about currency unification.
The best examples for the anti-inflationary parallel-currency approach
are the Massachusetts "equity bills" (1747-1749) and "depreciation notes"
(1780-1786), the notes issued by the (Congressional) Bank of North America
(17811783), the Soviet chervonets (1922-1924), the German rentenmark (1923-1924)
and the Hungarian tax pengö (1946). On the other hand, the parallel-currency
approach for currency unification (or a dual currency approach) has notably
been applied in France (13th-18th century),the United States (1791-1811,
1816-1836, 1863-1865) and Italy(1866-1927), and, as a limping
union-currency standard, in Britain (1844-1921), Germany (1875-1935)and
Japan (until 1882 ).If empirical tests and historical
precedents are capable of supporting a theory, then the case
for a European parallel currency should benefit from this support.